We Think Fnac Darty (EPA:FNAC) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Fnac Darty SA (EPA:FNAC) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Fnac Darty

How Much Debt Does Fnac Darty Carry?

The chart below, which you can click on for greater detail, shows that Fnac Darty had €1.08b in debt in June 2024; about the same as the year before. On the flip side, it has €607.0m in cash leading to net debt of about €471.3m.

A Look At Fnac Darty's Liabilities

We can see from the most recent balance sheet that Fnac Darty had liabilities of €2.70b falling due within a year, and liabilities of €2.08b due beyond that. On the other hand, it had cash of €607.0m and €165.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €4.01b.

This deficit casts a shadow over the €738.1m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Fnac Darty would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Fnac Darty has a quite reasonable net debt to EBITDA multiple of 1.7, its interest cover seems weak, at 2.5. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Unfortunately, Fnac Darty saw its EBIT slide 3.6% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Fnac Darty can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Fnac Darty actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Mulling over Fnac Darty's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Fnac Darty's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Fnac Darty is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.